February was a month of fierce action where the Sensex lost close to 5.2% m-o-m. The retraction from 24-month high to a 3-month low was contrary to the expectations at the start of the month. India was amongst the worst performing emerging market in February and gave up almost all its 12-month outperformance till date to finish last.
The global environment too remained volatile. Election results in Italy raised concerns on growth recovery in the EU. Minutes of the FOMC meeting raised concerns of an earlier than expected withdrawal of easy monetary policy in the US. But the Fed Governor subsequently assuaged markets on this issue. The confusion on economic outlook did reflect in return of risk-off trade during the later half of the month.
At home, all eyes were on the presentation of Union budget. The Railway budget did take some positive steps in terms of hiking fares and initiating some of the pending investments. The much awaited Union Budget failed to cheer financial markets as expectations were running high. The headline numbers did highlight reigning of FY13E Fiscal deficit at 5.2% and a budgeted improvement to 4.8% of GDP in FY14E. The market remains apprehensive on some of the growth assumptions in revenues given the softer growth undercurrent in the economy as of now. The subtlety of the numbers though indicates a conscious tilt towards accommodating global investors in the economic equation to achieve the targeted fiscal consolidation. One does remain hopeful of continuum of policy reforms outside the budget exercise.
Economic data on growth and Inflation remained mixed. December IIP disappointed the market coming in at -0.6% (consensus~1.1%), mainly due to 4% decline in mining and contraction in both capital goods and consumer goods. The 3QFY13 GDP growth also came much weaker than expected at 4.5% (consensus ~4.9%). WPI inflation for January at 6.6% was a three-year low. Core inflation eased to 4.1%. The focus now shifts to the RBI policy as the market builds up an expectation of 25 bps additional cut, on the background of these data points and the budget speech highlight of reducing CAD as a key outcome statement.
The budget created uncertainties on guideline on taxation of foreign investors making Tax residency certificate “a necessary but not sufficient condition” for claiming tax breaks under DTAA. One expects a prudent review of the slip-up on this issue given criticalities of global flows to markets as well as the economy. Apart from this, sustenance of government action on disinvestments, and incremental fuel price hikes continue to deliver the right messages.
Anticipation of right policy decibel resulted in FIIs investing US$4.5 billion over the month while DIIs were sellers of US$1.6 billion. YTD, FIIs have invested ~US$8.6 billion while DIIs sold US$4.8 billion for the same period. In spite of relatively robust FII inflows and moderating Gold and crude oil, INR depreciated 2.1% during the month. The domestic redemptions remain vital for any market direction.
The Q3FY13 earnings season provided a mixed bag. IT Services, Healthcare, Utilities and Energy sectors witnessed upgrades while Telecom sector witnessed downgrades by analysts. The budget proposals to increase surcharge on corporate tax does have an impact of ~150 bps on the consensus earnings. The street now estimates earnings growth of 11% and 15% for FY13E and FY14E respectively.
A lot has changed for India since mid-CY 12. Although the headline data series has worsened, the pessimism seems to be bottoming out. India has come a long way since - from a persistent negative rhetoric to a more pragmatic stance on policy regime. The budget is a statement of act where avoiding a populist splurge in a pre-election year and backing it up with right noise on the fiscal priorities has given the right signals to global capital market participants.
India is at an interesting inflection where one still foresees consistency of performance and return centric corporates. The current revival of sentiments has kindled the environ of positive reflexivity. Our belief in the India story as regards its core offer on domestic consumption, export competitiveness, supply side investment opportunities, and revival of policy and governance continues. Valuations are reasonable and sentiments provide a fertile bed for relative value investors to participate in the India story irrespective of global risk-on/off.
In an environment where market stands balanced at valuations, we remain focused to invest in both tactical as well structural opportunities that the market offers in terms of business quality (business model, earnings, cash-flow and management), re-engineering (operations, resources, balance sheet) and valuations.
The benchmark 10 year government security yield moved lower by around 10 bps over the month before the Union Budget, however, gave up all the gains on the budget day. The gross market borrowings for FY 14 has been budgeted at Rs 6.29 trillion as against Rs 5.58 trillion in FY13. This includes an amount of Rs 500 billion towards buyback/switch of government bonds maturing during FY15-17. The government has provided for buyback/ switch to stagger the impact of higher repayment obligations during the period FY15-17. This is an enabling provision and the sequencing of the same is likely to be decided by the RBI. The net market borrowings for FY14 has been budgeted at Rs 4.84 trillion as against Rs 4.67 trillion in FY13. The marginally higher net borrowing number resulted in an upmove in bond yields post the policy. Higher government balances with the RBI resulted in cancellation of the last scheduled borrowing program for the year. The RBI also conducted 2 OMOs amounting to Rs 200 Billion during the month to address the liquidity tightness in the banking system.
The government has announced the introduction of inflation indexed bonds, which is expected to moderate the demand for gold driven by inflation hedging requirements. The continuation of demand moderation efforts on the gold and petroleum imports would positively influence the market perception of funding and sustainability of the Current account Deficit (CAD). The withholding tax payable for FII investment in Rupee denominated long term infrastructure bonds have been reduced from 20% to 5% in line with the reduction made last year for foreign currency bonds. Policy measures in the recent months have further simplified the access provisions for FII investment in rupee denominated bonds.
Economic data releases have reinforced the recent trends of slowing growth and moderating WPI and core inflation. The RBI monetary review on March 19 is likely to determine the near term trends, with the review coming in the backdrop of the budget which has delivered on the deficit targets. Even as the monetary policy shifts towards supporting growth, the RBI's views on the quality of fiscal adjustment and trends on the current account deficit would determine the extent of additional near term easing. Banking system liquidity has remained tight along with incremental supply in short term securities and PSU bonds. This has resulted in short end AAA bond spreads widening over the month by around 10-15 Bps.
We have reduced duration by cutting Gsec exposure in our long term duration funds. While the medium term view remains positive, we believe there is a tactical opportunity at the short end of the corporate curve. Accrual products are also likely to benefit from the current spike in short term rates.
CIO – SBI Funds management Private Limited
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